«The nominal performance in equity markets over the next ten years in industrialized countries is expected to lie between 1 and 2 percent. Effectively, that means they will have the same returns as fixed income provides now,» writes Harald Preissler in a contribution for finews.first.
This article has been published on finews.first, a forum for authors specializing in economic and financial topics.
Consumer prices are increasing around the world at a breathtaking pace. This month alone, we could see numerous countries post double-digit increases.
There will be no return to the old comfort zone of less than 2 percent inflation even if the rate peaks this autumn. That won’t be the case even if the impact of the dramatic increases in energy prices starts to ebb. In the background, structural drivers are starting to have an ominous impact. These include widespread demographic declines in workforce populations, the cost of the energy transition to net zero, and ever-higher prices for industrial metals.
«Many investors came to the fatal conclusion that bonds are a toxic asset class»
What will the consequences be for the asset management industry? The main impact will be on fixed income, which experienced a veritable Tsunami in the first half of 2022. Interest rates shot up at a pace not seen in more than 20 years on both sides of the Atlantic.
Many investors came to the fatal conclusion that bonds are either a toxic or a dead asset class – something that no longer belongs in a multi-asset portfolio. Instead, increased emphasis was kept on equities given their expected average annual returns of 7 percent continued to be seen as a better inflation hedge.
It sounds good but it is a very simplistic calculation. If inflation starts falling and economic growth starts to weaken, something that looks very realistic over the next 12 months, the bond markets will price in a significant chunk of the discounted interest rate increases.
«They are anything but dead»
Returns would fall and bond prices would rise. US 10-year bonds could see gains of 15 to 20 percent if the American economy experiences a soft landing. On the other side, share prices would be expected to fall 20 to 30 percent in the same environment. The stabilizing impact of bonds in a crisis cannot be overstated. They are anything but dead.
But that is not enough. Looking further ahead, equity returns are expected to fall significantly. Profit margins are going to be weighed down by structural increases in interest rates, commodities prices, and the need to hold higher inventories. A sustained increase in demographic-related worker costs will also drive costs up. And last, declining productivity rates will lead to slower profit growth.
That is why equities are only going to rise by 1 to 2 percent over the next decade on average, which is what you currently get in fixed income.
«An alarming number»
Concretely, that means that after discounting the expected annual inflation rate of 3 percent over the next ten years, the cumulative loss on a passive securities portfolio will be between 10 and 20 percent – an alarming number.
What is important now is to have an active mix of all asset classes and a selection of appropriate themes and individual stocks. There is potential out there in hard-to-copy business models with stable margins and high pricing power. These are mainly in infrastructure, urban development, healthcare, and among the digital disruptors.
«Once upon a time»
Companies active in these sectors not only show a higher pace of innovation but are also relatively resistant to higher inflation rates – and some may even profit from it.
Completely avoiding bonds and having high index-tracking concentrations of equities will not pay off for investors. The bill will come in the form of high volatility and painful draw-downs. The golden era when it paid off to simply invest in the entire market to get above-average returns are over. Simply - that was all a big once upon a time.
Harald Preissler is Vice Chairman of the Board of Directors of Bantleon AG in Zurich and Chairman of the Supervisory Board of Bantleon Invest GmbH in Hanover. After studying economics at the University of Würzburg with a focus on monetary policy, business cycle and growth theory, mathematical economic theory and empirical economic research, he initially worked as a research assistant at the Universities of Würzburg and Ulm. In 1999, while still working on his doctorate, he joined Bantleon Bank (now Bantleon AG) in Switzerland as a senior analyst.
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